- A 401k plan is a defined contribution plan. The account is funded via salary deferral and optional matching contributions or profit-sharing contributions from the employer. Funds within a 401k account grow tax-deferred. Withdrawals are taxable and may be subject to a 10 percent penalty if the account owner is under age 59 1/2. Furthermore, many employers do not permit withdrawals from a 401k account until the employee has separated from service.
- The IRS allows for plans to offer a loan provision. However, there is no requirement that plans allow for 401k loans. IRS rules permit a 401k plan to offer loans of up to 50 percent of the employee's vested balance, up to a maximum loan amount of $50,000. The maximum loan amount allowed is reduced by the amount of any 401k loans made during the last 12 months.
- A 401k loan must be repaid with "substantially level payments." By law, such payments must occur quarterly; however, many plans require monthly payments. Furthermore, many 401k plans require that the payments be automatically deducted from the employee's paycheck. Loans must be repaid within five years, with the exception of loans used to buy your primary residence.
- Certain types of mortgage interest may be tax-deductible. However, a 401k loan is not considered a mortgage because such loans do not use the home as collateral.The 401k loan interest is not deductible as mortgage interest for this reason. The interest on all 401k loans is not deductible on income taxes regardless of what the loan proceeds are used for.
next post